Accuride and Rule 2019

Last week, the Wall Street Journal ran an article entitled: "For Accuride Investors, a Big Payday: Big Bondholders Parlayed Position at Negotiating Table During Bankruptcy Into $132 Million Gain." (subscription required). A number of people emailed me the above article and asked me my thoughts on it. But first some background.

For those interested, the Accuride docket can be found here: Accuride bankruptcy docket

In April 2010 (docket #968), Dow Jones & Company (publisher of the WSJ) submitted a motion to unseal the Accuride's ad hoc note holder's groups Rule 2019 disclosures which at that point had been sealed. What is Rule 2019 you ask? From the same motion:

"Rule 2019(a) requires that unofficial committees or ad hoc groups disclose, inter alia, (1) the nature and amount of their claims or interests; (2) the date of acquisitions of their claims or interests acquired in the year prior to the filing of the bankruptcy case; (3) the amount paid; and (4) any subsequent sales of claims or interests."

In other words what / when they paid for certain securities...

Eventually, after objections from the ad hoc group, the judge ruled to release the 2019 disclosures. The below document is where all the details can be found:

1181_13449

There was a very interesting quote from the aforementioned Dow Jones motion to release the 2019 disclosures:

"Chapter 11 proceedings have emerged as the preferred venue for mergers and acquisitions, where private investors quickly buy, trade, and break up companies. These investors may attempt to force a company into bankruptcy."

What is this? Pretty Woman?

In the article mentioned above, another interesting quote emerged. This time from Deirdre Martini, a managing director at Wells Fargo Capital Finance and former U.S. Trustee:

"The evolution of distressed investing has made a mockery of the underpinnings of our bankruptcy process, which is total transparency," said Deirdre Martini, a managing director at Wells Fargo Capital Finance and former U.S. Trustee, the government watchdog for cases in federal bankruptcy courts. Chapter 11 was created decades ago as a way to give ailing companies a chance to fix their balance sheets and operations, and reimburse supportive creditors as much as possible, she said.

"The bankruptcy code's focus was never intended to garner profits for distressed investors," she said.

Now that I completely disagree with. Whether it be the blanketed releases the code has ALWAYS allowed to the 2005 changes which has made pre-packs basically inevitable, the code has been welcoming to investors with fresh capital to rehabilitate debtors and capture a profit on that investment. Do you truly think anyone is going to put up $140M of capital and expect a mid single digit return on that capital for a bankrupt company?

The WSJ quote above, as it relates to the bankruptcy as the preferred M&A route for investors - of course it is. Have you ever actually read the releases involved in a confirming disclosure statement and plan? No one is liable for anything. Furthermore, given the litany of legacy liabilities and trial lawyers that profit from any ailment under the sun, why would any investor pursue M&A OUTSIDE of the Chapter 11 process.

Yes - The purpose of Chapter 11 is to rehabilitate ailing companies. But ailing companies' securities trade at a significant discount to their healthy peers. Would you like me to buy high and sell low?

If anyone is to blame, blame the management teams. No where in the entire WSJ article does the author point to how well management teams have profited from Equity Incentive plans granting management teams anywhere from 6-15% of the post-re org company.

And because the code allows a company the exclusive right to file a plan for the first 18 months after the petition date, distressed investors HAVE to work with management teams and offer them a very large carrot to ensure their plan is accepted. Is this collusion at the expense of pre-petition junior creditors and equity holders? Not in my opinion. Remember - always look at the incentives of every party in an investing situation - It really can tell you a lot about how the chips will fall.

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Happy Holidays from Distressed Debt Investing

Hey everyone - Wanted to wish you all a wonderful holiday season. I will be back next Monday with many a post in hand. Happy holidays!

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Advanced Distressed Debt Concept: "A Gift"

As noted many times on this site, Chapter 11 cases are expensive. From paying $700-$1200/hour for senior lawyers, success based fees for financial advisors, and (in my opinion the most important) business issues such as loss of customers, suppliers, employees, etc costs start to add up. That being said, and because of certain 2005 changes to the bankruptcy code regarding exclusivity timing, more and more bankruptcies are going the prepack bankruptcy route. And to make sure things go smoothly, the creditors driving the show are offering a gift to possible dissenting classes to make sure the Chapter 11 proceedings go off without a hitch.

Last week, after all the hub bub of the Great Atlantic's bankruptcy filing, people seem to have forgotten that Insight Health filed for bankruptcy just a few days earlier. Here is the press release:

InSight Health Services Holdings Corp. (“Insight Imaging” or “the Company”) (OTCBB:ISGT.ob - News) today announced it had reached an agreement in principle with holders of a significant majority in aggregate principal amount of its outstanding senior secured floating rate notes due 2011 (the “Notes”) regarding a restructuring of the Notes. Insight Imaging has entered into a restructuring support agreement (the “Support Agreement”) with such holders (the “Supporting Holders”), which contemplates restructuring the Notes through a jointly agreed plan of reorganization to be filed with the bankruptcy court (the “Court”). The terms of such pre-packaged plan are set forth in a term sheet made part of the Support Agreement, but may be amended or modified in accordance with the terms of the Support Agreement (a “Qualified Plan”). The terms of the Qualified Plan contemplate an exchange of all of the Notes for all of the common stock of the reorganized Company upon exit from bankruptcy, resulting in the elimination of 100% of the Notes from the Company’s balance sheet.

The Support Agreement provides that the Supporting Holders will, among other things, vote to accept a Qualified Plan and support a debtor-in-possession financing facility (the “DIP Facility”). The Company is currently in discussions with Bank of America, N.A. (“Bank of America”), the administrative agent under its current revolving credit facility, regarding the DIP Facility. The Support Agreement will require Insight Imaging and certain of its subsidiaries to file a Qualified Plan with the Court, obtain a confirmation order from the Court and effectuate the Qualified Plan within the time-frames set forth in the Support Agreement.

Insight Imaging also announced that holders of greater than 75% of the principal amount outstanding of the Notes, the trustee under the indenture governing the Notes and the collateral agent under the security documents relating to the Notes have entered into an agreement to forbear from exercising their remedies under the Notes, the indenture and related security documents as a result of events of default arising from the November 1, 2010 interest nonpayment and the expiration of the applicable 30-day grace period. The forbearance period ends not earlier than December 10, 2010, by which time the Company expects to have filed a prepackaged plan of reorganization. Bank of America has also extended the forbearance period under the Company’s revolving credit facility, as amended, from December 1, 2010 to December 15, 2010.

Kip Hallman, Insight Imaging’s President and CEO, stated, “This restructuring is being undertaken to eliminate more than $290 million of debt, substantially improving our cash and liquidity position. We intend to complete the reorganization as quickly as possible. In the meantime, we will continue to operate our business as usual to provide quality services to our customers and our patients. We look forward to emerging as a much stronger business, with a capital structure that will enable us to maximize the long-term value of the company.”

For those interested, you can find the Insight Health bankruptcy docket here: Insight's Chapter 11 docket

As those in the distressed community will know, this will not be the first trip to the rodeo for Insight. From the disclosure statement:

On May 29, 2007, InSight Health Services Holdings Corp. and InSight Health Services Corp. Filed voluntary petitions to reorganize their business under Chapter 11 of the Bankruptcy Code in the U.S. Bankruptcy Court for the District of Delaware (Case No. 07-10700) (the “2007 Reorganization”). The filing was in connection with a prepackaged plan of reorganization and related exchange offer. On July 10, 2007, the Delaware bankruptcy court confirmed InSight Health Services Holdings Corp. and InSight Health Services Corp.’s Second Amended Joint Plan of Reorganization pursuant to Chapter 11 of the Bankruptcy Code. The plan of reorganization became effective and InSight Health Services Holdings Corp. and InSight Health Services Corp. emerged from bankruptcy protection on August 1, 2007. Pursuant to the confirmed plan of reorganization and the related exchange offer, (1) all of InSight Health Services Holdings Corp.’s then existing common stock, all options for the common stock and all of InSight Health Services Corp.’s 9.875% senior subordinated notes due 2011, or senior subordinated notes, were cancelled and (2) Holders of InSight Health Services Corp.’s senior subordinated notes and Holders of InSight Health Services Holdings Corp.’s common stock prior to the effective date received 7,780,000 and 864,444 shares of newly issued common stock, respectively, in each case after giving effect to a one for 6.326392 reverse stock split of such InSight Health Services Holdings Corp.’s common stock.

While the reorganization attempted to deleverage InSight Health Services Holdings Corp.’s and InSight Health Services Corp.’s balance sheets and improve their projected cash flow after debt service, both still have a substantial amount of debt, which requires significant interest payments. As of September 30, 2010, the Debtors had total indebtedness of approximately $298.3 million in aggregate principal amount, including InSight Health Services Corp.’s $293.5 million in principal amount of Senior Secured Notes.

Looks like we have ourselves a good ole' Chapter 22 on our hands.

Who are the parties of interest here? Well we know a Plan Support agreement will have been filed in a pre-pack like this, so let's take a look at the disclosure statement and see what we can find. On page 494 - 496 of the PDF, one can see that J.P. Morgan's Credit Trading Group and affiliates of Black Diamond have signed the agreement. To give you a sense of how this bond has traded over the past few years, take a peak:

According to Trace (the graph above is based on Trace versus my message runs) there was a million + dollar worth of bonds traded on the 22nd of November. Alex Bea, a fantastic distressed debt trader from JPM who was the axe in this name, stoppped making markets sometime in October - thinking they got restricted and all that was left was sporadic runs from a number of brokers / dealers.

For the rest of this post, I will assume the bonds trade at 25 cents on the dollar. The allowed claim, according to the plan, of the Insight secured floaters is $293.5M with very little debt ahead of you in the capital structure. There has been a $15M DIP authorized which, according to the disclosure statement, will be rolled into a $20M revolving exit facility.

The disclosure statement also came with projections:

As you can see, the company plans to emerge with very little debt and a marginal cash balance. What does that mean for our bonds?

Insight Health has two direct publicly traded comps: Alliance Healthcare Services (AIQ) and Radnet (RDNT). Both stocks have had lackluster performance in the face of declining reimbursement rates in a predominantly fixed cost structure combined with hefty debt loads. According to Bloomberg, RDNT trades at 5.1x 2011 EBITDA and AIQ trades at 4.9x EBITDA. What does that mean for Insights bonds?

According to the projections, Insight looks to generate approximately $25M of EBITDA in 2012 (full year 2011 not really helpful given reorg costs). At 5.0x, this translates into $125M of value versus $293.5M of claims or 40 cents on the dollar - which at a purchase price of 25 gives us approximately a 25% IRR over 2 years. Not too shabby. Of course, if we haircut the multiple 1.0x turns reflecting the weaker mobile business of Insight, we get an IRR closer to 16%.

As we've talked about in previous posts, one really has to scrutinize projections. Why? Because management's incentive is to create a low valuation for the stock so their upside is greater. In Insight's case:

The Management Equity Plan will provide for a certain percentage of New Common Stock, not to exceed eight percent (8%) of the fully diluted New Common Stock, to be reserved for issuance as options, equity or equity-based grants in connection with the Reorganized Debtors’ management equity incentive program and/or director equity incentive program. The amount of New Common Stock, if any, to be issued pursuant to the Management Equity Plan, and the terms thereof shall be determined by the New Board on or as soon as reasonably practicable after the Effective Date.

The scrutiny of projections will be for another post. The question I am trying to address: If the floaters are going to make 16-25% in possibly artificially low projections and management is making off with possibly 8% of the company, what is happening to the equity? The equity is receiving a "gift".

You think I am using that term as slang. No, gentle reader, it really is called a a "gift":

Now what are the specifics of this gift:

• They are warrants to buy up to 2% of stock on a fully diluted basis
• Three year expiration
• Exercisable when enterprise value is greater than $215M

Exercisable when EV is greater than $215M? In 3 years?? $215M on the contemplated $25M of EBITDA is an 8.6x multiple. Or backing into the cash flow required on a more realistic 5.0x multiple, EBITDA would have to grow 20% a year for the next three years to reach $43M for these warrants to be in the money. In my opinion, highly doubtful.

If you had simply read that you were getting warrants for 2% of the company you may have been happy (albeit nearly a 99% drop in the stock) and have even considered getting long the equity in a spec play out of Gordon Gekko's playbook. But that gift is in all likelihood a donut to placate equity holders that just want SOMETHING. As I try to stress often on this site, I spend just as much time on the document side of things as I do looking at business and industry trends. Always read the fine print in distressed debt. It can save you many a land mines in the future.

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Great Atlantic Bankruptcy (GAP)

Before I begin, I need to correct something I wrote last night introducing the GAP bankruptcy: Rejected lease claims are unsecured claims in a bankruptcy. The GAP 2nd lien notes should be senior to these rejection claims. Chalk it up to lack to sleep. For you real bankruptcy buffs: 502(b)(6) of the Code sets damages at the greater of one year or 15% of the lease (not to exceed three years). Apologies on my part. Net/Net it helped the recovery of the bonds. To note, bonds are up 3-4 points today (went out the day 83-34/flat).

Now to the fun stuff: Great Atlantic announced its decision to file Chapter 11 in the Southern District of NY. To access the docket, you can go here: http://www.kccllc.net/APTea

Now, the DIP is definitely large - but the increased size is to account for taking out existing LOCs and pre-petition bank debt. The DIP will be structured as a $450M RC and a $350M term loan. Pricing is talked at L+750 with a 1.75% Floor. From the docket: "...to secure an $800 million debtor-in possession financing facility, consisting of (i) a $350 million term loan facility to refinance the Debtors’ prepetition senior secured credit facility and provide approximately $187 million in incremental liquidity and (ii) a $450 million revolving facility, including access to a $250 letter of credit sublimit and (b) grant adequate protection to the Debtors’ secured lenders." Essentially, this number was near the upper limit allowed under the pre-petition intercreditor agreement.

As noted in previous posts, one of the most important documents to get yourself associated with a new bankruptcy proceeding is the First Day Affidavit. You can find GAP's here: GAP's First Day Proceedings Affidavit.

A few interesting takeaways from the document:

• "The Debtors’ primary retail operations consist of supermarkets operated under a variety of well-known trade names, or “banners,” including A&P, Waldbaum’s, SuperFresh, Pathmark, Food Basics, The Food Emporium, Best Cellars, and A&P Liquors. As of September 11, 2010, the Debtors reported total assets of $2.5 billion and liabilities of $3.2 billion. The Debtors currently employ approximately 41,000 employees. "
• Points out three "significant legacy costs" - Dark store leases, an unfavorable supply agreement with C&S Wholesale (a high yield issuer itself), employee costs (pensions, high labor % of sales)
• LTM Revenue: $8.4B, down from $9.5B in 2008 and $8.8B in 2009
• LTM EBITDA and EBITDA Margin: $104M and 1.2% respectively, down dramatically from 2008 of $333M and 3.5% respectively.
• 95% of employees under collective bargaining agreements (39 separate agreements)
• Paid $1.4B for Pathmark in 2007
• "The Debtors’ estimated dark store net rental expense will be $77 million in 2011 alone."
• Cap Structure:
• 
• Sames Store Sales down 6.9% YTD
• Cost Savings Efforts Paying Off: "These initiatives have already generated total cost savings of approximately $40 million on an annualized basis, including over $10 million in annual salary savings"
• Really putting a lot of blame on C&S through this entire document.
• $858M of NOLs and $121M in business tax credits

Will be a very entertaining case. Interestingly a few months ago, one Distressed Debt Investors Club member pitched the second liens as a long (they were in the high 60s at the time) right when another member pitched the unsecured bonds as a short. Been a tough ride for 6.75% of 2012:

We will continue monitoring the GAP bankruptcy - think this one could get interesting.

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One of my favorite pieces of investing from Michael Price

Michael Price is a legendary investor and someone I try to learn from whenever I get the chance. I mean, this is one the guys that taught Seth Klarman how to invest capital. A few years ago, Michael Price gave a speech to Bruce Greenwald's Value Investing course at Columbia Business School. While I do not have the transcript directly in front of me, his words can be summarized as follows: "Read proxies and bankruptcy disclosure statements because they tell you what rational buyers are paying for businesses."

Now this is not theoretical data - i.e. this stock should trade at 6x or 9x - this is a real buyer, with real capital at risk, deploying that capital to buy a certain asset or company. And that information holds value and is very rarely discussed or even analyzed by the sell side.

For those that are interested on Bloomberg, you can make a macro to type in NSE "PREM14 A", and assign that macro to a button and have all the proxies filed at the tip on your hand. For disclosure statements, the process gets a little trickier - you have to monitor the docket to determine when the disclosure statement actually gets filed.

To be sure, many times this information needs to be sensitized relative to company specific factors. For example, I think it would be ludicrous to use most on the run proxy statements to value a distressed company in the same industry. Or if a company is heavily capital intensive versus an asset light company in the same industry - those companies should trade at different multiples because of the ability of the asset light company to better translate EBITDA into real tangible free cash flow. Make sure you are comparing apples to apples here.

Let's take a real world example: On Friday, Great Atlantic said it may file bankruptcy as soon as this weekend. Great Atlantic is always a hot topic among distressed investors. I know many people that bought near dated puts on the company thinking that any rescue effort would fall short. Seemingly it has. Rumors were swirling around the market on Thursday with bonds down 4 or 5 points on the session and then dropping further on Friday.

In January of this year, Penn Traffic, a regional grocer that has filed three times in the past ten years, sold substantially all its assets for $85M to Tops Markets. Here is the disclosure statement: Penn Traffic 2nd Disclosure Statement. According to the Affidavite of the Chief Restructuring Officer:

"Tops proposed a multifaceted transaction pursuant to which it would acquire a substantial number of stores as going concerns with commitments to employ the unionized workers at those stores, act as the Debtors’ liquidation agent with respect to underperforming stores to conduct going out of business sales and liquidate the merchandise in the Debtors’ closing stores, extinguish approximately $72 million of prepetition withdrawal liability claims which otherwise would have been asserted by one of the Debtors’ multi-employer pension funds, and consensually reduce by approximately $27 million the claim of the Debtors’ largest supplier."

Using $85M, and the 2009 financials, this represented ~0.1x revenue, 7.7x adjusted EBITDA. What does this mean for GAP?

• LTM Revenue is ~$8.5B. Using PTFC's multiple gets you to $850M valuation
• LTM EBITDA is $100M. Using PTFC's multiple gets you to $770M

***Note - I have edited this section for an error I made last night - score it at "Error - Lack of Sleep" for viewers at home***

But this is where things get tricky. GAP has talked about in previous conference calls there is a $100M cash flow loss from dark store rent. Seemingly in a bankruptcy they could get rid of these leases. There is ~$130M available outstanding on the term loan, ~$140M in cap leases, as well as a plethora of other claims: Long term real estate liabilities, pensions, etc.

Where does this leave us on our $260M of the 11.375% notes. Normalized EBITDA is probably somewhere between $150-$200M after adding back the lease losses. Using $150M and 7.7x multiple gets you to $1.15B in value. Less $130M in term loans, $140M in cap leases gets you to about $900M in value. But given how fast a grocer turns over its inventory as well as a large number of LOCs on the balance sheet, I believe a DIP here will be fairly substantial. For the last 4 years, accounts payable at the 4th quarter is around $200M, so I'll use that. We then have to add in admin expenses. I generally model 2-5% of total debt outstanding depending on the complexity of the case - I'll use 3.5% here which is another $50M of claims.

We are down to $650M in value versus our 11.375% notes. This leads me to believe these bonds are the place to play in the structure - I wish they were lower, but at 80 cents on the dollar, you are getting a decent (albeit possible inadequate) margin of safety here. Other reasons: The 2nd lien notes are guaranteed by the operating subs whereas all other debt (other than credit facility) is not. The bank debt looks to be money good here and seemingly the 11.375% quotes will be the fulcrum security.

We know we have any interested party here: Yucaipa is deeply involved here. Do they step up to take out the fulcrum security to gain control of GAP once and for all? Other things that keep me interested in this case: GAP has a number of brands they could sell to interested parties. While food deflation is all the rage among grocers, I believe this a temporary phenomenon. An investment in GAP's second lien notes may be one of the cheapest ways to play a wave of food inflation over the next few years. And remember, a rational buyer bought similar assets just 10 months ago at the 7.7x valuation - call them crazy if you think I shouldn't be using that multiple. We will continue to monitor this distressed debt case closely in the coming months.

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